The coming consumer crunch
Recession or not, American families will be forced to tighten their belts
The long-awaited, long-feared consumer crunch may finally be here. That might not mean an economywide recession, but the pain for American households will be deep.
In recent years the U.S. mostly has seen narrowly focused downturns, where a few sectors are hit hard while the rest of the economy and financial markets remain relatively unscathed. In the dot-com bust of 2001, for example, tech companies and stocks took it on the chin, while consumer spending and borrowing sailed through without a pause. This time the positions will be reversed, as consumers tank while much of the corporate sector stays on track.
It's been a glorious run for the consumer. In the past 25 years, Americans have kept shopping through good times and bad. In every quarter except one since 1981, consumer spending rose over the previous year, adjusted for inflation. The exception was the first quarter of 1991, and even then the decrease was a mild 0.4% dip.
The subprime crisis, however, marks the beginning of the end for the long consumer borrow-and-buy boom. The financial sector, wrestling with hundreds of billions in losses, can no longer treat consumers as a safe bet. Already, standards for real estate lending have been raised, including those for jumbo mortgages for high-end houses. Credit cards are still widely available, but it may only be a matter of time before issuers get tougher.
What comes next could be scary—the largest pullback in consumer spending in decades, perhaps as much as $200 billion to $300 billion, or 2%-3% of personal income. Reduced access to credit will combine with falling real estate values to hit poor and rich alike. "We're in uncharted territory," says David Rosenberg, chief North American economist at Merrill Lynch, who's forecasting a mild drop in consumer spending in the first half of 2008. "It's pretty rare we go through such a pronounced tightening in credit standards."
Next year, though, will be much tougher. The consumer slump may be deep and long-lasting, and the political implications could be enormous. "There's growing evidence that the economy will become a dominant, if not the dominant issue of 2008," says independent pollster John Zogby. "It's even to the point where the numbers of people who say Iraq is the No. 1 issue are starting to decline."
Wide-open credit window
Truth is, economists have been complaining about excessive borrowing and spending since the early 1980s. Journalists began writing about consumers being "tapped out," "profligate," and "spendthrift." Magazines and newspapers regularly ran stories about debt-ridden Americans not being able to buy holiday presents for their kids.
But no matter how many times economists predicted the demise of the consumer, the spending continued. The latest data from the Bureau of Economic Analysis show that the personal savings rate — the share of income left after consumption — fell from 12% in 1981 to just over zero today. And debt service, which is the share of income going to principal and interest on debt, kept rising. Those numbers aren't dead-on accurate: The data has been revised endlessly, and the BEA includes outlays on higher education as consumption rather than saving, which would seem odd to families who have socked away thousands of dollars for college.
But the story line is clear. Consumers' outlays have outpaced the growth of their income for a long time. Lenders learned how to judge risk and expand the pool of potential borrowers—and the party was on. "The most important factor has been that it is easier to borrow," says Christopher D. Carroll, a Johns Hopkins University economist.
While many companies struggled in the 2001 recession and afterward, American consumers just kept borrowing. "In 2001-02, the credit window was open for anyone who had a pulse," says Merrill's Rosenberg.
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